Irving Picard, the trustee hired for the recovery, has filed more than 1,000 suits seeking about $100 billion, including suits for fictitious profits over the last six years of Madoff's operation, for principal from investors who allegedly had reason to suspect Madoff was a fraud, for money that flowed through feeder funds and overseas banks, and for "preferences," sums that Madoff paid in the 90 days before bankruptcy.

That's almost six times the $17.3 billion in valid customer claims Picard estimated this month, representing the amount of cash invested less withdrawals. And that's why valid claims were trading at about 71 cents on the dollar, representing investors' bet that they would be paid in full, discounted by the amount of time it would take for the payments to come through.

Rakoff derailed that potential gravy train by throwing out about $9 billion of claims Picard was seeking against HSBC Holdings Plc, barring him from suing for $3.5 billion in preferences, erecting a higher barrier to suits for $14.4 billion in principal payments from defendants who may have suspected fraud, and limiting his claims for fictitious profits to two years instead of six.

The time limit ruling has cut the total transfers sought by the trustee from customers to $8.3 billion for two years from $19.3 billion for six years, Picard said in a statement on his website today.

In the "worst-case scenario," Rakoff's decision means the "total potential reduction in recoveries would be approximately $11.1 billion," the trustee's statement said.

Picard has requested permission to take an appeal to the U.S. Court of Appeals from Rakoff's Sept. 27 decision. Picard's papers point out how Kimba M. Wood, another U.S. District Judge in New York, disagreed with Rakoff in a different Madoff suit and is allowing a lawsuit to go forward in pursuit of preferences, six-year profits, and six-year principal repayments.

Since Rakoff's ruling, spreads on the value of claims on Picard's eventual recoveries have "widened considerably," according to Andrew Gottesman, head of claims trading for SecondMarket Inc., which tracks such trading. Claim buyers have bid as low as the "high 50s," Gottesman said.

Settlements

Picard has already taken in $8.7 billion, principally through settlements, he said in a statement this month. Picard will also distribute another $2.3 billion that Jeffry Picower's estate has to pay to the U.S. government. Picard isn't able to distribute most of the $11 billion because of appeals some customers have filed against the distribution formula and the settlement.

Of the $19.3 billion that Picard sought in total six-year transfers, about $5 billion represented preferences or fictitious profits where the trustee was facing little in the way of viable defenses. On those claims, the defendants' ability to pay what they owed represented the biggest question mark to recovery.

If Picard doesn't collect any of the $14.4 billion in principal repayments to those who allegedly should have known there was fraud, the $11 billion he has may be bolstered by almost $5 billion he seeks in judgments for preferences and six- year profit disgorgements, according to his website. That would mean a recovery on valid claims of about 90 percent.

If Picard were to realize even a few billion in recoveries from customers who knew there was fraud, customers with valid claims will wind up being made whole for their net cash investments in the Madoff firm.

Picture Changes

The picture changes if Rakoff's decision is upheld on appeal and Picard is barred from suing for $11.1 billion in preferences and payments beyond two years. The $2.22 billion in two-year profits, if collected in full, would give customers recoveries of about 76 percent, given the 63 percent dividend just from paying out the $11 billion already on hand. The trustee would have to win and collect $4.1 billion of his remaining $6 billion in lawsuits for principal before customers would have a 100 percent recovery.

If Picard collects the full $17.3 billion to cover the net cash invested in the Madoff firm, customers may recover some of the lost profits shown on their fictional account statements. Under the Securities Investor Protection Act, the excess above customers' net cash investment claims would go first to reimburse the Securities Investor Protection Corp. for expenses of the liquidation. For their lost profits, customers would have claims for fraud to recover alongside creditors with general unsecured claims, Picard's web site says.

Rakoff based his ruling on the so-called safe harbor law in Section 546(e) of the Bankruptcy Code, which bars a trustee from suing to recover payments made by a stockbroker.

Supposed Profits

Rakoff restricted Picard's ability to sue customers for so- called fictitious profits, or gains in supposed purchases of stocks. In reality, Madoff never purchased any securities with customers' investments. Instead, Madoff was paying out supposed profits by stealing money from other customers.

In his appeal to reverse Rakoff's ruling, Picard will argue, akin to the rationale in Wood's opinion, that the safe harbor shouldn't apply because the Madoff firm wasn't operating as a broker.

The Madoff firm began liquidating in December 2008 with the appointment of Picard as trustee under the Securities Investor Protection Act. Bernard Madoff individually went into an involuntary Chapter 7 liquidation in April 2009. His bankruptcy case was consolidated with the firm's liquidation. Madoff is serving a 150-year prison sentence following a guilty plea.

The Madoff Liquidation case is Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, 08-01789, U.S. Bankruptcy Court, Southern District of New York (Manhattan). The criminal case is U.S. v. Madoff, 09-cr-00213, U.S. District Court for the Southern District of New York (Manhattan).

--With assistance from Linda Sandler in New York. Editors: John Pickering, Pat Oster.